IRS Announces Sweeping Enforcement Effort Targeting Partnerships
The IRS announced a "sweeping" and "historic" enforcement effort focused on partnerships and is establishing a special group within its Large Business and International (LB&I) Division to focus exclusively on large and complex pass-through entities. According to IRS Commissioner Daniel Werfel, "[w]e are honing-in on areas where we believe non-compliance among our wealthiest filers has proliferated over the last decade of IRS budget cuts, and pass-throughs are high on our list of concerns." Therefore, the new unit "will leverage Inflation Reduction Act (IRA) funding to disrupt efforts by certain large partnerships to use pass-throughs to intentionally shield income to avoid paying the taxes they owe." This expands the IRS' recent increased focus on partnerships. We've seen a significant increase in partnership audits in the last several years.
The IRS is hiring more than 3,700 people nationwide to assist, and the work group will formally start late next year. In the meantime, partnership audits will continue to ramp up. Many partnerships will likely receive notices soon, including:
- Partnerships with $10 Billion in Assets. The IRS will expand its large partnership compliance program that launched in 2021 and is currently opening audits of 75 of the largest partnerships in the U.S. These include hedge funds, real estate investment partnerships and publicly traded partnerships that average $10 billion in assets.
- Partnerships with $10 Million in Assets and Balance Sheet Discrepancies. The IRS will send compliance letters to 500 partnerships with more than $10 million in assets and balance sheet discrepancies. The number of discrepancies between year-end and beginning year balances on balance sheets have been increasing, and many taxpayers are not attaching the required statements explaining the differences. Due to the IRA funding, the IRS now has the resources to follow up with taxpayers regarding the discrepancies and may audit the partnerships depending on the response.
Partnership Audit Selection and AI
The IRS will use "improved technology as well as Artificial Intelligence that will help IRS compliance teams better detect tax cheating, identify emerging compliance threats and improve case selection tools." This is the result of a "groundbreaking collaboration between experts in data science and tax enforcement" to apply "cutting-edge machine learning technology to identify potential compliance risks" in partnerships.
Partnership Audits Are Complex
If selected for audit, many partnerships will be subject to the procedurally complex partnership audit rules. Under these rules, the default is that the partnership pays an entity-level tax – called an imputed underpayment (IU) – on any adjustments. This means that, unless certain steps are taken, the current partners would bear the tax even if they weren't partners for the year under audit. To navigate these procedurally complex rules and ensure the correct tax is paid by the correct partners, the partnership and its representative must make a number of time-sensitive strategic decisions. For the five time-sensitive actions that a partnership or its representative should take within 30 days of receiving notice that it has been selected for audit, see Holland & Knight's previous alert, "IRS Partnership Audits: 5 Must-Dos in 30 Days," April 24, 2023.
For Further Assistance
Holland & Knight is well situated to represent partnerships in an IRS audit or litigation. The firm's tax attorneys – many of whom include former IRS counsel and others with significant government experience – are frequently quoted on partnership compliance efforts, have testified before the IRS on the partnership audit rules and have decades of experience handling partnership tax issues and controversies. Please reach out to the authors or another member of the Tax Practice if you have any questions.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.